Investors May Hate Bonds, but They Keep on Buying

They are the investment everyone suddenly hates to love, but those bonds that were supposed to collapse this year continue to attract billions in investor money.

For many Wall Street strategists 2013 was expected to be the year of the Great Rotation. That's the name given to a much-anticipated exodus of money from bonds into the stock market that, nearly a quarter into the year, has failed to materialize.

"We've been seeing money come into both markets. People who have tried to short the Treasury market haven't met with much success," said Kim Rupert, managing director of global fixed income analysis for Action Economics in San Francisco. "Every time it seems safe to start to take some off of the safe-haven trades, something pops up to bite you."

But while bond returns have been weak this year - with Treasurys down 2.3 percent and bonds overall gaining 4 percent, according to Barclays indexes - fund flows have not. In fact, bonds and equities have been about equal this year, with about $55 billion in inflows apiece, according to the Investment Company Institute.

Cash appears to be flowing into stocks from money markets, which have lost just shy of $50 billion, but fresh money is going into bonds as well.

"We're in a deflationary environment, which is still strong for bonds," said Keith Springer, president of Springer Financial Advisory in Sacramento, Calif. "There's still a lot of pessimism out there...Bonds are not necessarily for the returns, but they produce less volatility in a portfolio."

Wall Street strategists have been divided over the bond theme, with Bank of America Merrill Lynch pushing hard on the Great Rotation theme but other firms, such as Morgan Stanley, a bit more cautious.

"The range of our expectations is not so bearish that we think it's safe to be structurally short bonds," Morgan Stanley strategists said in a research report. "So, while our base case is that one should have a bearish bias in 2013, we don't expect that it will be right for investors to hold a permanent underweight in bonds."

The firm's forecast for the most likely scenario puts the benchmark 10-year Treasury yield at 2.50 percent by year's end - a good move higher than the current yield around 1.90, but not far outside the high end of the 2012 trading range.

Bond buying, particularly Treasurys, will be supported in large part by the Federal Reserve, which this week indicated no expectations to veer from its $45 billion-a-month purchase program.

Foreign investors are helping as well. China, for instance, increased its government debt holdings to $1.26 trillion as of January, a nearly 10 percent increase since September, according to Treasury data.

Investor strategy for bonds, then, might not be much different than stocks - buy when the market drops and be nimble.

"You might pare back at higher levels and came back in for dip-buying when we see prices drop again," said Rupert, of Action Economics. "I'm not sure it's time to exit."